Once the shutdown ends, China, with its massive holdings of US Treasury bonds, will be carefully watching Congress wrangle over the federal debt ceiling. Photo: MCT

How have financial markets reacted to news of the shutdown?

After declining seven out of the past eight sessions on concerns about a possible shutdown, Wall Street rebounded on Tuesday as investors viewed the pullback as a buying opportunity in the absence of an extended shutdown.

The Dow Jones industrial average rose 62.03 points, or 0.41 per cent, to close at 15,191.70. The Standard & Poor’s 500 Index rose 13.45 points, or 0.8 per cent, to close at 1,695. The Nasdaq Composite Index rose 46.50 points, or 1.23 per cent, to close at 3,817.98.

Some analysts said investors may also be reasoning that the crisis could delay the so-called “tapering” of the US Federal Reserve’s recession-busting policy of quantitative easing, which helps inflate share prices by pumping cheap money into financial markets.

Ilya Spivak, currency strategist at Daily FX, said: “The somewhat counterintuitive response seems to reflect investors’ continued preoccupation with the direction of US monetary policy. Filtered through this prism, the shutdown and its negative implications for US growth are seen as delaying a move to ‘taper’ QE asset purchases, which seems to be driving a swell in risk appetite.”

So does that mean it’s just a little local difficulty for the Americans?

Yes and no. The direct economic hit may be relatively small: analysts at the ratings agency Moody’s suggest a week-long outage could cut a relatively manageable 0.3 per cent off US gross domestic product. But a serious knock to confidence could rattle consumers and investors at a crucial time.

The US recovery remains fragile, as the Fed stressed last month when it decided to continue buying US$85billion a month worth of bonds, instead of tapering QE.

A major wobble, throwing the spotlight back onto the health of the US public finances, is the last thing the nascent upturn needs; and it could also exacerbate markets’ anxiety in the run-up to the potentially fraught debate over raising the government’s budget ceiling in mid-October.

What about the rest of the world?

Any prolonged shutdown would rapidly start to hit US consumer spending, as hundreds of thousands of public sector workers are furloughed; and that will crimp America’s demand for imports from the rest of the world.

At the margins, weaker investor confidence and the dollar depreciation that has so far been the main financial impact of the shutdown could also slow the flood of capital into the US that was one of the key trends in international markets over the summer.

The switch from riskier markets to the perceived safety of America drove up exchange rates and bond yields in many emerging economies, forcing central banks in several countries, including India and Brazil, to take emergency action.

A renewed sense of crisis in the US is likely to stem that flow, particularly after the Fed had already raised questions about the health of the US economy when it declined to taper QE in September.

What will China think?

Beijing’s attitude is the key to one of the more subtle potential implications of this latest budgetary wrangle.

China holds a mountain of US assets, mostly Treasury bonds, effectively IOUs from Washington – the by-product of running huge trade surpluses over the past decade and a deliberate policy to keep the Chinese currency, the yuan, cheap.

However, Chinese politicians have repeatedly expressed concern over recent years about the growing risks of this large exposure to the US, as Washington has appeared increasingly unable to bring tax-and-spending policy under control.

When the US was stripped of its AAA credit rating by Standard & Poors in August 2011, after a previous partisan wrangle over raising the government’s debt ceiling – not a problem suffered in autocratic single-party states – China reacted with fury.

Xinhua, the official news agency, said: “The days when the debt-ridden Uncle Sam could leisurely squander unlimited overseas borrowing appear to be numbered. To cure its addiction to debts, the US has to re-establish the common-sense principle that one should live within its means.”

Since then, China has deliberately moved towards making the yuan more convertible on international markets, which would allow it to appreciate, and reduce the need to pile up potentially risky US debts – a policy that in the long term could remove the biggest buyer of US debt from the markets, potentially making it far more costly for America to borrow.

Simon Derrick of BNY Mellon suggested the lack of outraged comment over the current budget impasse may suggest “the Chinese government has already made its mind up about what it needs to do and sees little point in complaining any further”.